The 4th Wharton Conference on Liquidity and Financial Crises, Wharton School, Philadelphia PA., 9-10 October 2015. How to Cite?

Abstract

This paper studies the joint determination of optimal contracts and equilibrium asset prices in an economy with multiple principal-agent pairs. Principals design optimal contracts that provide incentives for agents to acquire costly information. With agency problems, the agents' compensation depends on the accuracy of their forecasts for asset prices and payoffs. Complementarities in information acquisition delegation arise as follows. As more principals hire agents to acquire information, asset prices become less noisy. Consequently, agents are more willing to acquire information because they can forecast asset prices more accurately, thus mitigating agency problems and encouraging other principals to hire agents. This mechanism can explain many interesting phenomena in markets, including multiple equilibria, herding, home bias and idiosyncratic volatility comovement.

This paper studies the joint determination of optimal contracts and equilibrium asset prices in an economy with multiple principal-agent pairs. Principals design optimal contracts that provide incentives for agents to acquire costly information. With agency problems, the agents' compensation depends on the accuracy of their forecasts for asset prices and payoffs. Complementarities in information acquisition delegation arise as follows. As more principals hire agents to acquire information, asset prices become less noisy. Consequently, agents are more willing to acquire information because they can forecast asset prices more accurately, thus mitigating agency problems and encouraging other principals to hire agents. This mechanism can explain many interesting phenomena in markets, including multiple equilibria, herding, home bias and idiosyncratic volatility comovement.